For vendors and purchasers of businesses, goodwill can be a vague term, and understandably so considering it’s the legal term used for assets that are fundamentally intangible. For people who are considering or are in the process of selling a business, or for people considering purchasing a business, understanding what goodwill means can help navigate the sale of business process. Practically, this can also have a potential impact on the purchase price or the tax consideration of the transaction. This article will explore the meaning of goodwill in more detail through examples and how to determine its value.
What is Goodwill?
Goodwill is an intangible asset of the business. However, it obtains its value as it is a necessary element for the business to continue operation. People often describe it as the “capital infrastructure” of the business.
From the purchaser’s perspective, you should consider what benefit you can obtain and commercially exploit from the goodwill. This advantage can include benefits the purchaser will receive from pre-existing client relationships or the business’ reputation in a particular industry developed from well-developed advertising campaigns in the past. Although these are elements of the business that the purchaser cannot grasp, it is invaluable to a buyer that intends to continue operating the business after the purchase.
It’s important to highlight that goodwill may not be considered an asset for business purchases that are solely relating to the acquisition of plant, equipment and stock.
For example, let’s say you wanted to start operating a new takeaway chicken shop. You’ve found the perfect location where the current business is running a kebab store. Goodwill may not then be a factor in the sale of business transaction. This is because the likely assets that you will be purchasing from the kebab store owner are limited to the equipment (stove, ovens, refrigerators, etc.) or fittings (counters, display cabinets, tabletops, etc.). Technically you will not be continuing to operate the kebab store, so there may be limited goodwill to transfer to your new takeaway chicken shop.
Are There Any Other Examples of Goodwill?
Not all of the assets listed below will be relevant to every sale of business transaction. However, goodwill can take the following forms:
- Brand identity;
- Network of customers;
- Good reputation amongst customers;
- Expected growth and sales prospects; and
- Good reputation in the market.
Why is Goodwill Important?
Goodwill is important as it is an asset in the business that takes time and effort to generate. For a vendor, goodwill is important in a sale of business transaction as it rewards them for the time and effort it took to generate.
For a purchaser, goodwill is significant as it places you in a competitive position within the market. That is because the vendor has already established the groundworks for the business and you can continue operating by maintaining the goodwill. For example, ensuring that your employees reach the same standard of customer service as beforehand or keeping up any advertising campaigns the business had undertaken previously.
How Do You Determine the Commercial Value of Goodwill?
Determining the value of goodwill is unfortunately not as straightforward as it is ultimately a commercial consideration. That means that it is often subject to negotiations throughout the sale of business transaction.
If you are a purchaser in the transaction, it is important to complete your due diligence to determine what value you would place on the business’ goodwill. This due diligence may involve analysing customer reception to the business as well as understanding how the vendor has operated the business in practice.
For vendors of a sale of business transaction, knowing the value of goodwill is important so that you can gain monetary consideration for the establishment of your business and negotiate with this in mind.
Are you in the process of going through a sale of business? Get in touch with our sale of business lawyers on 1300 544 755.